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This chart compares Berkshire's stock performance to the S&P 500 from 1977-2009. Berkshire's average annual gain during that span was 27.7%, versus 8.8% for the S&P.

As we all know, the story has been different recently. Last year, Berkshire was up 2.7% compared to the S&P up 23.5%. The P/Book ratio at the end of 2009 was somewhere around 1.2x. The last time Berkshire closed the year at a price of 1.2x book was in 1987, when a share sold for $2,950.

Anybody who bought then enjoyed a nice double dip during the years to come as book value compounded rapidly and the P/Book ratio expanded. Looking at year-end P/Book ratios, the peak was in 1995 at 2.2x book. In 1994 and 2001, 2.0x. Those three years were the only ones where we closed the year at 2.0x or better.

As recently as 2007, we closed the year at 1.8x. But by the end of 2008 it had dropped to 1.4x, and now even that poor chump who bought in 1987 at 1.2x is back to where he started. Sure, he paid $2,950 and rode it to $99,200, multiplying his money 34-fold. But that's because book value increased 34-fold. In terms of the P/Book ratio, he has now gone full circle. Life is hard.

The P/Book ratio, of course, is a simple way to summarize the consensus expectation for future growth. Measured by that yardstick, the consensus expectation for Berkshire's future growth is the same today as it was at the end of 1987. As it turned out, the consensus then was spectacularly wrong. The question we all want to answer is whether today's ratio also is wrong.

Well....you tell me Berkshire's book value 22 years from now and I'll tell you the answer.

Everybody knows that Berkshire is too damn big and its top management is too damn old. Book value growth during the last ten years already has slowed down to around 8% annually. In the good old days from 1979-1999, book value went from $335 to $37,987. The math was easy. As a rule of thumb, you could add a zero every ten years. But that was then.

In June of 2006, WEB announced his gift to the Gates Foundation. The stock then was selling for between $91-92K/sh. That was just under 1.5x book value at the time. WEB said:

"I regard Berkshire as an ideal asset to underpin the long-term well-being of a foundation. The company has a multitude of diversified and powerful streams of earnings, Gibraltar-like financial strength, and a deeply-embedded culture of acting in the best interests of shareholders. Outstanding managers are available to succeed me. I expect Berkshire to become ever-stronger and more profitable as it makes new acquisitions and expands present businesses."

He also said that although his annual number of shares donated would decrease by 5% each year, "I believe that you can reasonably expect the value of Berkshire shares to increase, in an irregular manner, by an amount that more than compensate for the decline in the number of shares that will be distributed."

In other words, he projected an annual price increase of more than 5%. He added:

"In the future, I expect the value of my annual gifts to trend higher in an irregular but eventually SUBSTANTIAL manner." (Emphasis added.)

So how much more than 5%? He didn't say, but apparently substantially more.

Now let's look at what has happened since then. Had the stock increased at the predicted "floor" rate of 5% (it closed at $91,659 on 6/30/06), in 3 1/2 years it should have been selling for between $108-109K.

And if by "substantially more" he was thinking, say, 9% appreciation a year, the stock would have to be selling around $124K by now.

Measured by book value, which was $63,319/sh on 6/30/06, and let's guess mid-80K range at 12/31/09, the growth rate has been 8 or 9%--pretty good considering what has happened to the economy since 2006.

But I don't think WEB expected Mr. Market would downgrade his P/Book ratio to 1.2x when he made his gift.

The Owner's Manual still says that WEB thinks IV "far exceeds" book value. I can't believe that he thinks this means 1.2x book. At a minimum, I'd guess he thought that the P/Book ratio at the time he made the gift would hold, albeit in an "irregular" manner. If that had happened, of course, the stock would be selling north of 120K/sh.

Why has the P/Book ratio dropped? Some point out that many well-regarded property casualty stocks sell today for 1.2x book or even less. That no doubt is part of it. Insurance prices are soft and the yields on their bond portfolios are low. Many investors, including WEB, think inflation is bond to flare up one of these days, and that interest rates will surely rise. All of these things are a bad combination for insurance companies and their stock prices reflect it.

While Berkshire faces many of these same problems, I think it is in a much better position than its competitors. It doesn't have the bulk of its assets tied up in low-yielding bonds. It owns a number of businesses that should be able to earn much better earnings coupons than bonds, and those coupons should increase over time. Its float is cheaper and its spread is wider. Even for those who view the BNI acquisition as a mistake because they think it is a "5% coupon bond" (I disagree), they acknowledge that the BNI coupons at least should grow in line with GDP growth.

So in my view, Berkshire does not deserve to sell at 1.2x book.
When I look at the assets we own, the earnings yields on those assets and the almost $100B of "free financing" on our balance sheet (combined float and deferred taxes after BNI is added), it seems likely that the P/Book ratio ought to move higher. Only two years ago, the stock closed the year at 1.8x book. Berkshire was big then and its top managers were already ancient. But Berkshire was reporting "good comps" and making a killing on hurricane insurance, and people jumped on board as the stock headed up.

Who knows what the catalyst might be this time or when it might happen. But history would suggest that we are probably at or very near the bottom in terms of P/Book ratio. Investors who buy now, or hold now, are starting at the same ratio that prevailed on 12/31/87, and have a good chance of enjoying a nice double dip going forward.